HKEX hoped alchemy would turn acquisition of century-old London Metal Exchange into ‘super-connector’ gold. What went wrong?
- After March’s trading suspension, HKEX has started an internal review at LME. Separate reviews by the Financial Conduct Authority and the Bank of England have also been initiated
- HKEX’s Nicolas Aguzin remains optimistic about LME and says the bourse remains ‘well positioned’ to benefit from its links with China
The fiasco was triggered amid heightened geopolitical tensions and global inflationary pressures, as Russia’s invasion of Ukraine sparked global supply concerns and sent the price of nickel soaring.
The acquisition of LME was intended to boost commodities trading in Hong Kong as part of China’s 12th five-year plan. Li also made it clear that the deal represented a major step towards diversifying the bourse’s business away from equities and HKEX becoming a “international bourse operator”.
“Unlike equities, where there are fewer concerns when corporate issuers choose to diversify their listing venues outside their home markets, commodities are often closely associated with a government’s strategic resources,” said Bruce Pang, head of macro and strategy research at investment bank China Renaissance.
“Given that LME is a global pricing hub for metals, it would be more challenging for HKEX to serve various stakeholders through LME without first tackling scrutiny arising from various geopolitical interests,” he added.
Nicolas Aguzin, HKEX’s current CEO, continues to be optimistic. “A big proportion of the world’s commodities is produced in China. More importantly a lot of commodities are consumed in China,” he said during a media briefing after its first-quarter results were announced late last month. “So there is a lot of room for LME to continue to benefit from that long-term trend. We are well positioned.”
Because of China’s capital controls, LME has not been able to expand its network of more than 500 authorised warehouses in the country. Without more onshore warehouses, LME’s settlement prices for any of its zinc, copper, aluminium and nickel contracts would be irrelevant for traders in China, the world’s top producer of non-ferrous metals at 64.5 million tons in 2021, observers said.
HKEX has since 2019 launched six base metals mini futures contracts denominated in US dollars that reference LME prices, and the contracts are settled in Hong Kong. These are “mini” as each comprises 5 tons of metals, rather than the 25 tons per contract traded on LME.
But these mini contracts have not drawn in much liquidity. For the first quarter of 2022, these six products traded 90,289 lots, doubling from the same quarter a year ago, but were still far short of the 89.1 million lots traded by the Shanghai Futures Exchange. Trading fees from the exchange contributed HK$280 million to HKEX’s total revenue of HK$4.7 billion (US$598.8 million).
LME also faces competition in China from the country’s own commodities futures exchanges, which are also slowly opening up to foreign investors. The Shanghai International Energy Exchange, a subsidiary of the Shanghai Futures exchange, for instance, already allows foreign investors with an initial margin of not less than 100,000 yuan (US$15,132) or equivalent foreign currency to trade bonded copper futures, crude oil, iron ore, technically specified rubber 20 and low-sulphur fuel oil futures contracts.
This could form the basis of a “commodity connect”, linking China’s vast commodity markets with LME, HKEX has said.
Despite the challenges of overseas expansion, LME is expected to continue enjoying its status as the reference for global metal pricing, industry players said, even as mainland Chinese exchanges are attracting more trading volumes.
“With over a hundred years of history, LME has always been the benchmark for physical transactions,” said Arthur Fan, head of Asia-Pacific at commodity-focused financial services firm Marex.
“Its settlement prices are hard-wired into many physical trade contracts and this makes it hard to be replaced.”